Energy Opportunities in the Looming Sequester

The looming sequester has commentators talking about tax loopholes. Apparently, many people find loopholes to be unfair and possibly un-American. But in the energy sector, tax incentives are not always loopholes.

Congress believed that achieving energy independence and energy security were in the national interest. So it provided incentives for companies to invest their private capital to increase domestic energy production. Most of these incentives had limited scope; they reduced the income tax liabilities on short-term profits, and they had no effect on long-term profits.

The key word is "profits." No bureaucrat is shoveling cash out of the U.S. Treasury and into company coffers. Only profitable companies can use most of the tax incentives.

Unfortunately, not all tax incentives designed by Congress are equal. Some energy sources qualify for one type of tax relief while others qualify for different benefits. This disparity is causing energy companies to fight each other over a perceived limitation of a critical resource: tax incentives.

A good example is the utility Exelon (EXC). The company has engaged in a high-profile fight with the wind industry over tax credits. Exelon claims that tax credits for producing wind power are unnecessary. Companies such as NextEra Energy (NEE), which generate energy from sources that include wind and solar, claim that without tax credits, they would withhold investments in additional wind power projects.

At the same time that Exelon is engaged in a public campaign against wind power, it remains silent about the tax benefits Congress gave to the nuclear power industry. Apparently, Exelon believes nuclear power is entitled to help from big government.

Exelon may be right. NextEra may also be right. The oil and gas industry may be right. Tax incentives work, and they may be necessary.

Elevating the discussion above the fray, we are reminded that political leaders from both parties claimed that all energy options are on the table. They also claim that the nation needs to invest in infrastructure, create jobs, lower corporate tax schedules and stimulate the economy.

If political leaders agree, then retaining tax incentives may make some sense. The nation needs decades worth of coal, nuclear, renewable energy, petroleum, natural gas, electricity and energy efficiency. Rather than picking winners and losers, why discriminate? Why not declare all of them winners and treat them the same?

After all, the more the nation invests in energy independence, the more the nation saves in military, intelligence and other federal expenditures. Does it really matter if electricity originates from a solar farm or a gas turbine? Does it matter if power demand is met with demand-response or additional production? From the viewpoint of independent power markets, the answer is clearly no.

The same can be said about oil, natural gas and, to some extent, coal. Energy markets are generally fungible, and they are indifferent about the source.

Rather than simply extending existing tax credits, maybe the sequester provides an opportunity to simplify incentive policies. One simplification would be to end discrimination and treat all energy sources the same. This avoids having the government pick winners and losers.

Another simplification would include investments in energy transportation systems. This would cover new investments in piping, wiring, rail, trucks, barges, refining, processing, docking and energy efficiency. It would cover the entire value chain, including demand-side management.

With nondiscriminatory incentives, successful projects would earn tax credits and depreciation. For the first few years, new enterprises would not be required to pay federal income taxes. But they would be required to pay new payroll taxes, new state income taxes and new property taxes. They would also have multiplier effects on local businesses.

After a few years of successful operations, depreciation and credits become exhausted. With fewer expenses, the business floats to a higher tax bracket. In the case of wind and solar, they would likely be elevated to the highest possible tax bracket. At these higher tax brackets, the federal government reaps new taxes.

When considering the total cost of ownership over the life of the asset, the taxman ultimately gets a payday. It may be delayed, but the U.S. Treasury ultimately receives far more than it gave.

It is in the nation's interest to have companies such as Exxon Mobil (XOM), Chesapeake Energy (CHK), ITC Holdings (ITC), American Electric Power (AEP) and thousands of midsized and small companies invest in U.S. energy. If the government deals an even hand, investors can decide where and how they want to invest.

Tax incentives for the energy industry are not evil loopholes. They are effective instruments that can stimulate investment and growth. They can also help North America reach energy security and perhaps energy independence. In the end, a dollar invested in the U.S.' energy future could be more than a dollar saved in its military security.